JOHANNESBURG, Oct 29 (Reuters) - Bad loans at small South African banks rose in the first half of this year, the central bank said on Wednesday, disclosing a worrying trend just months after the collapse of unsecured lender African Bank.

However, impaired advances at the five largest banks - Standard Bank, FirstRand, Barclays Africa , Nedbank and Investec - contracted by 2.1 percent to 81.8 billion rand ($7.53 billion), the Reserve Bank said in its latest financial stability report.

“Although the assets of other local banks represent less than 10 percent of the South African banking sector’s assets, this development needs to be closely monitored, especially in view of the possible interconnectedness with the rest of the financial sector,” the bank said.

Overall, bad debt in the banking system declined marginally to 3.5 percent of total loans from 3.6 percent six months earlier.

The central bank said there were indications of increasing credit stress in the retail sector as credit card defaults rose by 11 percent and defaults in vehicle and asset finance went up by 14.8 percent in the six months to June 2014.

South Africa’s unsecured credit exposure has been falling since a peak in November 2012 but African Bank’s implosion under a mountain of defaulted loans in August sent ripples through the financial sector in Africa’s most advanced economy.

The central bank had to step in and placed the bank under external supervision and arranged a $940 million rights offering of shares underwritten by other local lenders. It also separated Abil’s good loans from a 17 billion rand ($1.5 billion) “bad book”, which it took over for 7 billion rand.

African Bank collapsed mainly because its business model was to lend expensive uncollaterised loans to lower income earners. But many South Africans have been feeling the pinch of rising prices and unemployment and have struggled to keep up with loan repayments. ($1 = 10.8561 South African rand) (Reporting by Helen Nyambura-Mwaura; Editing by Tiisetso Motsoeneng and Ed Cropley)